Retail investors: Beware Hong Kong shenanigans

Commentary: Changes in listing rules raise questions

HONG KONG (MarketWatch) -- Should you be trusted to buy your own shares or leave it to the professional money managers?

This question could come into focus as proposed changes in Hong Kong listing rules, meant to deliver a bourse more friendly to mainland Chinese investors, move a step closer.

Last week saw a reshuffle of the Hong Kong Exchange board as investor activist David Webb was replaced after recently resigning in protest at developments such as back door political meddling at HKEx and plans to set up a "professional only" board.

In the current market environment, with a renewed focus on emerging market risk and mainland China's equities in a prolonged slump, signs that Hong Kong is planning to water down its listing rules are controversial to say the least.

The proposal for a professional board, which is now moving to a consultation phase, would ban retail investors from trading and would mean some existing listing requirements could be bypassed. The thinking is that if these higher-risk investments are only open to so-called professional investors, they should be better prepared if things do go wrong.

Similar boards do exist elsewhere -- such as the Nasdaq 144A or London's AIM -- although in largely institutional exchanges.

But there is reason to believe a different agenda is emerging in Hong Kong that could alarm legions of armchair investors and individual stock traders. They may find that to access some of the best listings, they now have to buy via equity funds.

We know Hong Kong authorities have been troubled over how to consolidate their market's position as the mainland's listing hub, but in the hurry to achieve this, some interests may be sacrificed and Hong Kong's reputation may be put at risk.

In the past year the direction of HKex has come under the spotlight as foreign exchanges and China's domestic A-share markets take more of Hong Kong's traditional IPO business -- listing mainland companies.

In 2006, half of the 59 overseas China listings were in Hong Kong. That figure shrunk to 38% in 2007. Meanwhile Shanghai listings raised a massive US$15.8 billion in 2007, up 114% on year.

To protect the pillar capital markets industry in Hong Kong, various politicians have lobbied for more concessions from China under the Closer Economic Partnership Agreement (CEPA).

Last year it looked as if Hong Kong was in luck, as Beijing announced a "through train" of mainland investors, sending the market to huge new highs. The Hong Kong government was even more fortunate in having controversially acquired a 5.7% stake in HKEx before hand.

The news gave Hong Kong a taste of life as a mainland equity market, as daily turnover doubled to HK$180 billion. HSBC Securities described Hong Kong as a "re-emerging emerging market" to justify the higher prices and what appeared to be waves of irrational buying.

To date, the through train has yet to depart, however. It is believed policy makers in Beijing have reservations about novice mainland investors coming to the big sophisticated Hong Kong market and losing their shirts -- although we can see done that can easily enough at home. But there is also likely a concern about controlling these funds once they arrive in Hong Kong as China edges towards making its currency convertible.

So, has the HKEx, with its new government shareholders, hatched a plan to satisfy its biggest listing client?

A report by the Bauhinia Foundation -- a think tank believed to be funded by local tycoons and to have the ear of the government -- gives some clues. It argues: "Hong Kong will gain an added advantage of being a stock market where IPO issuers can tap vast savings of mainland residents." As at June last year there was 17 trillion yuan on deposit in China.

The next paragraph in the report says there is a restraint on a diversified selection of products in the Hong Kong market seen as highly retail-driven which could be remedied if rules were changed to sanction higher-risk products that can only be marketed to qualified or professional investors.

So perhaps if mainland investors bought these new IPOs through intermediaries in a "professionals only" market, it might suit Beijing. The authorities in China are, after all, used to controlling where companies list and could easily direct choice listings here.

But now everyone, not just mainland investors, would have to buy through funds.

It's unclear if these proposals will see the light of day, as we should expect some strong comments in the consultation.

It would look like a step backwards if Hong Kong were to become more like a mainland equity market to win business by reducing listing standards. It is also hard once you change the rules to know how they might be used.

While Hong Kong's GEM market was launched in 2001 to be a funding incubator for young companies without a profit track record, it was quickly latched onto by local tycoons to spin off a series of mega-IPOs.

The proposals are also unlikely to go down well with Hong Kong's savvy retail investors who are used to trading for themselves, often eschewing funds or life products.

Ultimately, any plan hatched against the backdrop of a market bubble may well look less appealing in more sober times. Now that China A shares are in a deep rut, mainland investors' interest in shares -- be they listed in Hong Kong or China -- may be gone for some time.

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